How to fund your high-tech start-up

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Silicon Valley, Silicon Alley, Silicon Beach, and every other high-tech locale in the country is full of start-ups, founded primarily by people who have left lucrative positions at larger companies for the thrill of becoming an entrepreneur and the potential for million-dollar post-IPO rewards.

But there's more to being an entrepreneur than getting a great idea, quitting your day job, and setting up shop in your garage. You need money, and lots of it.

The four phases of funding

Funding your start-up doesn't start at the venture capital (VC) stage. In fact, there are as many as three previous steps through which your project will have to go through before a VC will even look at it.

The full funding cycle looks something like this:

  1. Back pocket funding. Nobody is going to fund a project unless you've put everything you have into it first. This is the stage where you put yourself into hock. If you have a house, mortgage it. If you have credit cards, max them out. If you have a new Cadillac, sell it and buy a used Dodge. Borrow against any assets you can get your hands on -- life insurance, retirement accounts, stocks and bonds. Forget security and forget about saving for your golden years; you have to lay all your chips on the table. You're an entrepreneur now, and at this stage, you're about one step below a riverboat gambler.
  2. Friends and family funding. This stage may or may not be fruitful, depending on what kind of friends and family you have -- but you'll need to make a list of everyone you can think of, bake some apple pies and go visiting with your hat in your hand. Even if your brother-in-law won't lend you any money, there's always possibility that he may know someone who may be interested in your project.
  3. Angel funding. Here's where it gets a little more formal. An angel is not a venture capitalist, but is typically someone in your industry with a strong interest in your project. An angel is well-connected, usually a power broker, and can be very useful to you in your attempts to hook up with the right people -- including venture capitalists, industry visionaries who you will want on your board, and seasoned executives who may be looking for a new challenge. In exchange for an equity position, the angel may also provide initial seed capital, ranging between tens of thousands up to about a million dollars.
  4. Venture capital funding. Once you have something to show, a venture capitalist will come in and provide the millions you need. Don't be intimidated; a venture capitalist is just a regular guy (or gal), probably with the same interests as you, with a kid in Little League and a power mower in the garage he uses every other Saturday. The only difference is that he is sitting on hundreds of millions of dollars in available funds, and you would like to have some of it.

Touched by an angel

Business angels typically don't advertise in the yellow pages, and they may not even know they're going to be an angel until they're presented with the right idea. While your angel may come from your circle of friends and family, more typically he or she will come from your circle of industry contacts. Steve O'Neill, cofounder of ThinkLink, an integrated messaging start-up, found his angel in the Boston public library. "The database at the public library allowed me to sort public companies by size, phone number, who were the insider owners that owned at least 5 percent of the company, and who was on their board." From that information, O'Neill was able to determine the founding members of public companies who were likely to have money to invest.

Getting to the VC

One route is to write a business plan, go to the library and get a list of VCs, and mail your plan out to them. This route, however, is typically a dead end. Most venture capital deals are made after an introduction has taken place. If you're not fortunate enough to know several venture capitalists personally, don't despair.

Larry Spear and John Nix, cofounders of Gotocall.com, a resource for Internet-based telephony, were students at the Kellogg Business School when they started to seek funding for their company. They didn't know any venture capitalists, and none of their friends or family knew any either. But, they reasoned, business school alumni probably would. Knowing that alumni tend to be sympathetic to students, the two started cold- calling from the alumni list, making brief phone presentations to explain their concept and to ask for assistance. Their strategy eventually paid off, and they made the connections they needed -- nailing down $3 million in venture funding in December 1999.

Another way to make connections with VCs is by attending trade shows and conferences. Joe Ruben, cofounder of the family-based Website Hey Network, found his VC at the New York Venture Capital Conference, which he describes as "one of the biggest places that start-ups and young companies go to seek venture capital in the New York area."

What the VC Wants

Years ago, business schools taught you to write a solid business plan and stick to it. In the Internet economy, things move fast, and you have to be willing to change your plan, sometimes dozens of times. VCs do want to see a business plan, but mainly just to get a sense of whether or not you've done the necessary preparation. They will look at your financials, but only to see whether you've thought out the idea. But, as Steve O'Neill puts it, "It's all pie in the sky. You have no idea what your company will do in five years; it's impossible to know in most cases. They know that, they're just looking to make sure that you've done your homework."

Be prepared to answer a lot of questions from very smart people, advises Mike Shultz, cofounder of QuestLink, a Web-based resource center for electrical engineers. "I would never apply the word 'easy' to the process," he says. Shultz founded Questlink in the early days of the Internet, and so besides trying to explain the concept of his company, he had to explain the Internet itself.

Everything else is common sense. Present a VC with a great idea -- something that nobody else has done -- and be able to show the VC that you've already put a substantial amount of time and money into the project, and you're already halfway there.

Dan Blacharski is the author of three books on computer networking, and writes extensively on the subjects of business and e-commerce. He and his family live in Santa Cruz, California. You can reach him at dblach@pacbell.net.

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